The China Pivot: This Time Is Different

Ox Capital has always believed  the “perceived” structural problems in China are well discounted by the cheap valuations of Chinese stocks. Furthermore, the underlying issues are less severe than commonly believed for a few reasons.

1. Ageing Demographics and GDP: China’s GDP growth has driven productivity growth not population growth. GDP per capita is only USD12,600, far below that of developed economies. GDP per capita growth will continue as the country develops.  
2. Property sector weakness: The bulk of the property market adjustment has already taken place. The authorities are finally putting a line in the sand by aiming to “achieve no further price declines and stabilise property prices”.
3. Regulatory crackdowns for private businesses: With the authorities’ focus on economic growth, heavy handed regulatory pressure on the private sector has peaked.
4. US-China Competition: This will persist. Unfortunately, the HK market was caught in the middle. With some international capital having departed, the HK market was severely discounted. In response, regulators in HK and China are planning to channel Mainland capital to invest in the HK market. Furthermore, following recent news of economic stimulus, foreign funds have already started to return.

At Ox, we believe this time is different. The authorities are addressing the important issues.

1. Deflation: Weak asset prices have been a main drag for the economy. The ex-Governor of the People’s Bank of China (PBOC) publicly urged strong policies to fight deflation.
2. The Stock Market: The authorities showed clear intention to support the stock market. The PBOC is going to allow non-bank financial companies, such as insurers, asset managers and brokers to swap their bonds for cash to invest in the stock market. The initial facility is RMB500bn in size and offered more if needed. From our perspective, this is significant, as it means the PBOC is going to use its balance sheet to support stock prices! Furthermore, there are plans to set up special financing channels for public companies for buybacks, and PBOC is open to setting up a stock stabilization fund.
3. The Property Market: The aim is to stabilise the property market which implies a higher tolerance for property price appreciation. These new stabilisation measures include mortgage rate cuts, down payment requirement cut to 15% for first and second properties, financing for local governments to buy back inventories in the market, and banking support for whitelisted developers.
4. Injection of capital into the banks: This will enable the banks to more readily lend.

In addition, there are more policies being considered.

1. Local Government Financing: The Central Government plans to take over some of the debts from the local governments. More importantly, the Central Government is considering tax reforms e.g.  allowing local taxes to be collected by the local governments. These new measures will improve local government’s fiscal positions, which has suffered from weak land sales.
2. Consumption Stimulus: Direct stimulus to provide incentives for consumption and lifting income tax tax-free threshold to boost disposable income.

While China has some structural issues, not unlike most other major economies, we have always believed that the key drag to the HK/China share market was a lack of willingness to sufficiently relax policies to tackle the deflationary impulse resulted from property market adjustment. It appears that the direction and magnitude of these new measures can potentially address these challenges.

The stock market related measures have the potential to re-invigorate the market and so far the impact is encouraging with share market trading volume in both the Mainland and HK surging with rising stock prices. The property market relaxation policies should stabilise prices.

If the authorities follow up by tackling some of the longer-term issues, such as local government finances and income distribution (via taxes and direct transfers), this can improve the fiscal sustainability, defuse risks for the economy and boost end consumption demand.

This pivot from the authorities can ignite the long-awaited Chinese economy reflation. Given the extremely attractive valuations, upside from here can be highly rewarding.

At Ox Capital, we are focused on quality companies with long term growth which are available at inexpensive valuations across emerging markets. Current valuations are providing lots of interesting opportunities. Let us know if you would like to understand specifically where we are finding the opportunities!

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